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Real Options In Mine Project Budgeting - Polish Mining Industry Example


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J. A. Drieóa, J. Kicki, & P. Sa»uga


Real options in mine project budgeting -Polish mining industry example J. A. Drieza1, J. Kicki2, & P. Saluga3 1 Department of Electrical Engineering, University of Mining and Metallurgy, Krakow, Poland 2 Department of Mining, University of Mining and Metallurgy, Krakow, Poland 3 Minerals and Energy Economy Research Institute, Polish Academy of Sciences, Krakow, Poland Abstract Traditional methods of capital budgeting often fail to assign the proper value or timing to management decisions. The theory of option pricing can produce a valuation that resolves these issues. This paper compares the results of two capital budgeting approaches on the example of Polish zinc-and-lead mining. Option pricing approach is used to value the project and find the best operating strategy. The sensitivity analysis due to volatility of zinc prices and defer mine opening time is considered. 1 Introduction Most investment decisions share three important characteristics in varying degrees. First, the investment is partially or completely irreversible. In other words, the initial cost of investment is at least partially sunk -you cannot recover it. Second, there is uncertainty over the future rewards from the investment. The best you can do is to assess the probabilities of the alternative outcomes that can mean greater or smaller profit (or loss) for your venture. Third, you have some leeway about the timing of your investment. You can postpone action to get more information (but never, of course, complete certainty) about the future. These three characteristics interact to determine the optimal decisions of investments. The basic inadequacy of the net present value (NPV) approach and other discounted cash flow (DCF) approaches to capital budgeting is that they ignore, or